Optimal income taxation with asset accumulation

Several frictions restrict the government's ability to tax assets. First of all, it is very costly to monitor trades on international asset markets. Moreover, agents can resort to non-observable low-return assets such as cash, gold or foreign currencies if taxes on observable assets become too high. This paper shows that limitations in asset observability have important consequences for the taxation of labor income. Using a dynamic moral hazard model of social insurance, we �find that optimal labor income taxes typically become less progressive when assets are imperfectly observed. We evaluate the effect quantitatively in a model calibrated to U.S. data.